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What is factoring?
Accounts receivable financing, also known as factoring, is a powerful financial tool that has
fueled the growth and success of a number of companies. Factoring enables companies to
capitalize on their unpaid receivables by selling them to a factoring company for immediate
payment. With factoring, companies immediately get paid for their invoiced work from the
factoring finance company, while the factoring company waits to be paid by the customers.
Factoring strengthens a business' cash position by shortening the time to get invoices paid to 48
hours and providing the needed funds to meet current expenses and target new opportunities.
As opposed to loans and lines of credit that require that the client have tangible assets and strong
financials, factoring relies more heavily on the financial strength of the clients' customer. This is
a critical feature, since many new and small businesses do not meet the financial criteria of
traditional lending institutions. However, many small businesses have a roster of financially
strong customers that can be leveraged. Factoring empowers businesses to capitalize on their
customer list, and provides them with a tool to transform outstanding receivables into immediate
cash, without generating debt. Since Factoring is not a loan, it is an ideal financial product for
o New and emerging businesses including small and home businesses, consultants and
o Businesses with financially strong customers
o Businesses that are preparing to grow significantly
o Business with intangible assets (e.g. consultants)
o Businesses that do not want to take a loan
An additional benefit of factoring is that the factor usually assumes part of the clients' credit risk
for the customer. This means that if the customer becomes financially insolvent due to
bankruptcy and does not pay the invoice, the factor will assume the loss. This is a critical service
for small companies who may not be able to afford the bankruptcy of a customer.
The costs of a factoring transaction – also known as the discount - vary based on a number of
variables such as the financial strength of the customer and the amount being factored.
Generally, the discount is a percentage of the invoice's face value that increases with time until
the invoice gets paid. Small businesses, those that have between $20,000 and $300,000 in yearly
revenues, can expect to pay a discount rate of about 2% for every ten (10) days that the invoice
remains unpaid. Businesses with factorable revenues in excess of $300,000 can expect lower
Factoring at Work: Business Services and Products, Inc. Case Study
Business Services and Products, Inc. (BSP, Inc.) is a small fictional company, which provides
business consulting and equipment to local companies. It has $300,000 of annual revenues and
during the past year BSP Inc. has enjoyed significant sales growth. Although most business
owners would be very happy to manage such a company, Jane Sullivan, BSP Inc's president, is
very worried about her company's financial position.
Most of BSP Inc.'s customers are large companies with a good reputation for always paying their
invoices. However they always take between 30 to 45 days to pay them. BSP Inc., however,
needs to pay their employees every two weeks and their vendors every four weeks. This
discrepancy between the time that customers pay their bills and the time BSP Inc. needs to pay
their employees and vendors has created cash flow problems in the past. Furthermore, these cash
flow problems have already caused Jane to delay payroll twice this year and have placed her
trade (vendor) credit in jeopardy multiple times. This has also caused her to pass on a number of
significant business opportunities because she was unsure of the company's financial ability to
hire and pay for additional staffers. Unfortunately, BSP Inc. did not have a large enough
financial cushion in the bank to afford paying employees while waiting for 45 days new clients
to pay their invoices.
The following table provides an overview of BSP, Inc's current financial position.
Business Services and Products, Inc (without financing)
Lost new sales opportunities: Unknown
Total Sales: $300,000
Variable Costs (60% of Sales): $180,000
Fixed Costs (Rent, phones, etc): $20,000
Total Costs: $200,000
Profit (Sales – Costs): $100,000
Although the company's prospects appear great, Jane may have to stall her company's growth
until she builds a large enough cash cushion at the bank to finance her company's growth.
After careful consideration, Jane decided that a factoring line of working capital could help
strengthen her company's financial position. Furthermore, factoring her invoices would enable
BSP Inc. to take on new customers and continue growing, knowing that she could capitalize on
her slow paying customers. BSP Inc.'s financing agreement will provide the company with an
advance of 70% of her invoiced services. This means that the company can get 70% of the face
value of the factored invoices within 24 to 48 hours of submitting them to the factor. The
remaining 30% of the funds, less the factoring fees, will be quickly rebated as soon as the
customer pays their invoice.
This line of working capital strengthened the company's financial position and bank account,
enabling Jane to pay for new employees to service new contracts. Jane also decided to use the
extra capital to pay her vendors early, obtaining quick payment discounts and helping to reduce
the cost of factoring.
BSP Inc. customers pay their invoices within 30 days of receipt. The discount (factoring fee) for
these invoices is 6%. Every time an invoice is paid, the factor rebates BSP Inc. the remaining
30% that was not advanced less the factoring fee. This means that once the transaction is
completed, the factor rebates 24% (30% - 6%) to BSP Inc.
Thanks to the factoring line of working capital, Jane was also to secure an additional $120,000
worth of business, bringing her annual revenues to $420,000. The following table shows BSP
Inc.'s financial position a year after using factoring.
Business Services and Products (with factoring)
Existing Sales: $300,000
New Sales : $120,000 (factored)
Total Sales: $420,000
Variable Costs (60% of Sales): $252,000
Fixed Costs (Rent, phones, etc.): $20,000
Cost of Factoring (6% of $120,000): $7,200
Total Costs: $279,200
Net Profit (Sales – Costs): $140,800
As can be seen from the above table, factoring helped BSP Inc. increase profits substantially
from $100,000 to $140,800 - a 40% increase. It placed BSP Inc. on a more stable financial
footing, priming it for growth. Furthermore, the cost impact of factoring on the bottom line was
minimal, as it was easily absorbed by the additional business, showing that factoring was paid
for directly by the growth.
About Commercial Capital, LLC
Commercial Capital, LLC is a leading commercial finance company that specializes in providing
working capital through factoring to small businesses. For more information or a free
consultation, please visit our web site at http://www.ccapital.net or call us at (786) 206 4722.
|This article was submitted by - Marco Terry||Please Rate/Review this Article - Recommend it to friends|
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